Will U.S. Avoid Recession in 2012? (Part 1)

April 10 (Bloomberg) -- For several months, I’ve been
forecasting a recession in the U.S. this year, arguing that
weakened consumer spending -- the key to the economic outlook --
would tip the economy back into a downturn.

But what about recent positive data and markets? Do they
affect my forecast? Bullish investors will say I’m wrong,
pointing to the 29 percent increase in the Standard & Poor’s 500
Index from its October 2011 low.

-- Consumers Are the Linchpin: The U.S. economy is being
fueled these days by strong consumer spending, which increased
in February by 0.8 percent, its best showing in seven months,
after rising 0.4 percent in January. Retail sales rose 1.1
percent in February -- the fastest pace in five months -- while
same-store sales advanced 4.7 percent. These numbers correlate
with recent gains in consumer confidence and sentiment.

I don’t see this pace continuing. Personal-income growth
continues to be weak -- up just 0.2 percent in February --
meaning this recent exuberant consumer spending is being fueled
largely by increased debt and tapping of savings.

At the same time, pay per employee is rising slowly and
continues to fall in real terms. So increased job growth remains
the key to any increases in real household after-tax income,
which declined in February for a second straight month and
gained a mere 0.3 percent, compared with February 2011.

-- Spending, Saving and Debt: The support that consumer
spending has received from less saving and more debt appears
temporary. Household debt -- including mortgages, student loans,
and auto and credit-card loans -- has fallen relative to
disposable personal income, though. In my analysis, this is
largely because of write-offs of troubled mortgages.
Nevertheless, revolving consumer credit, mostly on credit cards,
is no longer being liquidated.

Non-revolving consumer credit continues to rise in response
to growing sales of vehicles -- most of which are financed --
and in student loans, as the poor job market keeps students in
school or sends them back. Tuition increases encourage more
borrowing, while interest costs on past-due loans mount.

It would seem, then, that contrary to my steadfast belief
that consumers are being forced to save more and reduce debt to
rebuild net worth, they have been doing the opposite lately. In
making the case for a long-run savings spree, I continue to
point to the volatility of stocks starting in 2000. That
volatility ended the belief of many individual shareholders in
the 1980s and 1990s that ever-rising stock portfolios would
substitute for savings and put their kids through college,
finance early retirement and pay for a few cruises in between.

But with the 2000-2002 dot-com-led stock collapse and the
2007-2009 subprime mortgage-driven nosedive, investors have
suffered through two of the five stock-market declines of more
than 40 percent since 1900. Furthermore, the S&P 500 index was
flat in 2011 and has experienced 13 years of drought since
1998. In response, investors continue to exit U.S. equity mutual
funds and pour money into bond funds.

With the house-price collapse and the earlier huge
withdrawal of home equity, consumers can no longer use their
homes as leverage for oversized spending. The profligate postwar
babies need to save for retirement, and they can. Many are in
their 50s, their peak-income years. Their offspring’s tuition
bills have disappeared with graduations and, if their kids are
like our four, they no longer have as many smashed-up cars to
replace. Also, those with jobs should be encouraged to step up
saving for contingencies, due to employment uncertainty.

-- Consumer Retrenchment: The data so far aren’t
conclusive, but evidence of U.S. consumer retrenchment is
emerging. Consumer confidence has moved up recently but remains
far below the levels of early 2007 before the collapse in
subprime mortgages set off the Great Recession. Real personal
consumption expenditures growth has been volatile in recent
months and falling on a year-on-year basis. Voluntary departures
from jobs, another measure of confidence, may be decreasing. And
consumer spending will no doubt have a big slide if my forecast
of another 20 percent drop in house prices pans out.

Housing activity remains depressed, with the only signs of
life coming from the multifamily component, which is being
driven by the appetite for rental apartments as homeownership
declines. Homeowners are losing their abodes to foreclosures;
many can’t meet stringent mortgage-lending standards; some worry
about homeownership responsibilities in the face of job
uncertainty; and many have no desire to buy an asset that
continues to fall in price.

-- What Oil Threat?: Recently, there has been great concern
about $4 per gallon gasoline and whether, as in 2008, those high
prices will act as a tax on consumer incomes and force drastic
cutbacks in other purchases.

These concerns are overblown. American consumers have
reacted to rising gasoline prices as you would expect in tough
times: by consuming less. Demand in the mid-February to mid-March four-week period was down 7.8 percent from a year earlier,
mainly due to more efficient vehicles. Americans drove 264.4
billion miles in December, up 1.3 percent from a year earlier,
but they used 2.5 percent less gasoline and diesel fuel.

As a result, the recent surge in gasoline prices has had a
relatively small impact on consumer purchasing power. The $14.8
billion increase from October 2011 to March 2012, compared with
the year-earlier period, amounts to about 0.3 percent of
consumer spending. After including the reduced costs of natural
gas, propane, electricity and heating oil, the net increase of
$5.8 billion is only about 0.1 percent of household outlays.

And the recent weakness in commodity prices has included
crude oil, whose price per barrel fell to $102 in the early days
of April, from slightly more than $110 in late March. The
increase in gasoline prices appears to have stalled, with the
average pump price remaining below the dreaded $4 per gallon
mark for several weeks.

Consumer spending is the only major source of strength in
the U.S. economy this year. State and local-government spending
remains depressed because of deficit woes and underfunded
pension plans. Housing suffers from excess inventories and may
face a further 20 percent drop in prices. Excess capacity
restrains capital spending. Recent inventory building appears
involuntary. So consumer retrenchment will tip the balance
toward a moderate and overdue recession.

Tomorrow, in Part 2, I’ll examine the employment picture
and how renewed job weakness will affect corporate profits and
consumer spending.

(A. Gary Shilling is president of A. Gary Shilling & Co.
and author of “The Age of Deleveraging: Investment Strategies
for a Decade of Slow Growth and Deflation.” The opinions
expressed are his own. Read Part 2, Part 3 and Part 4
of the series.)

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